IPS-Sendero KRM Basel II Solutions

IPS-Sendero KRM
Basel II Solutions
PT Bank BRI
May 2005
PT. Tridas Widiantara
Jl. Bulungan 1 no. 9
Jakarta – 12130
Phone 021-7254260
Agenda
 Overview of Credit Risk

 Overview of Approaches
 Standardised
 IRB Approaches
 IPS-Sendero KRM Overview
 IPS-Sendero KRM Basel II Solutions
 Default probabilities
 Regulatory Capital Calculation / Reporting
2 - - - IPS-Sendero confidential
Credit Risk Overview
Three Key Pillars of Success In Credit Risk
Fear :No matter how good your institution is in risk

management in general and credit risk in particular, bad
things are going to happen. Go looking for weaknesses
now and try to stop them before they happen. Be afraid
Links : The amount a counterparty owes you and their

probability of default are almost always correlated,
usually to your disadvantage
Macro Risk Drivers

: Risk and large scale correlation of defaults are driven
by macro economic risk factors, which means that
counterparty default probabilities change with every
change in these macro risk drivers. Identify macro risk
drivers and understand their impact on defaults for
every counterparty
4 - - - IPS-Sendero confidential Source : Credit Risk Models & the Basel Accord : Deventer & Imai 2003
Expected Loss (EL)
Transaction
Counterparty Specific
Specific
What is the
What will be our How much of this
probability that a
exposure at this are we likely to
counterparty will
point in time? lose?
default?
Probability of Exposure at Loss Given

Expected Loss = Default (PD) x Default (EAD) x Default (LGD)
Customer
Rating
Rating Limit Utilisation
Segment Collateral
Value
Collateral Workout
Type Costs
Costs
Overview of Approaches
Difference Between Approaches
Calculation of capital under the Standardised Approach:

0
20 Capital
Exposure x Risk Weight 50
100
150
x 8% = Requirement
Calculation of capital under FIRB:
Capital
EAD x K PD
, LGD
, M x 12,5 x 8% = Requirement
Calculation of capital under AIRB:
Capital
EAD x K PD
, LGD
, M x 12,5 x 8% = Requirement
Defined by Supervisor
Own estimation of Bank
Standardised Approach for Credit Risk
Rating
Claims on AAA to BBB+

A+ to A- BB+ to B- below B-
AA- to BBB- unrated
1 2 3 4-6 7
Sovereigns / Central Gov. 0% 20 % 50 % 100 % 150 % 100 %
Option 1 1 20 % 50 % 100 % 100 % 150 % 100 %

Banks
Option 2 2 20 % 50 % 50 % 100 % 150 % 50 %
BB-
Corporates 20 % 50 % 100 % 150 % 100 %
Retail 75 %
Other Assets 100 %
Higher Risk Assets 150 % National Supervisor’s Discretion
ABS 20 % 50 % 100 % 350 % Deduction
1
RW‘s corresponding to the sovereign RW‘s of the respective country
2
RW‘s corresponding to the rating of the individual bank
Standardised Capital Charge Example
Input:
Input: Standardised
StandardisedApproach:
Approach:
EAD 10,000,000
Corporate/Bank/Sovereign: 10,000,000*100%(Risk Weight)
PD 1% *0.08=800,000
LGD(FIRB) 45%
LGD(AIRB) 15%
Retail: 10,000,000*75%(Risk Weight)
M 5yr
*0.08=600,000
Rating Ba1
RW(STD) 100%
Drawbacks of Standardised Approach
 Though easier to implement, it often leads to much

higher regulatory capital requirements than IRB
approaches
 It does not create much value other than pure

compliance
Overview of the IRB Approaches
IRB Foundation IRB Advanced
Input Parameters: Input Parameters:
PD LGD EAD M PD LGD EAD M
Bank‘s own Bank‘s own Bank‘s own Bank‘s own Bank‘s own
Defined by Defined by Defined by
estimation estimation estimation estimation estimation
supervisor supervisor supervisor
CRM: CRM:
Guaratees / Financial /  Guarantees
CDs Phys. Collateral Netting recognised by
_________ _________ _________  Credit Derivatives
Transaction Rating 
 Financial Collateral
Decline of Decline of Reduction modeled into LGD
 Physical Collateral
PD LGD of EAD
Capital
EAD x K PD , LGD , M x 12,5 x 8% = Requirement
IRB Asset Classes
 Sovereign FIRB AIRB

FIRB
 Banks FIRB AIRB
FIRB
 Corporate FIRB AIRB
FIRB
Specialised Lending Supervisory Categories FIRB AIRB
FIRB
SME FIRB AIRB
FIRB
 Residential Mortgage AIRB
 Revolving Credits AIRB
 Other Retail AIRB
 Equity Market Based Approach PD/LGD Approach
 Purchased Receivables FIRB AIRB

FIRB
 ABS Rating Based Approach Supervisory Formula
Retail Segmentation Principles
 Risk Parameters are estimated at pool level (PD/LGD or EL)

 Pools are performed my by segmentation of retail sub-classes
according to institution specific criteria
 Must Criteria for segmentation:
 Borrower risk
 Transaction characteristics
 Delinquency status
 No. of exposures in a pool must be sufficient to support
statistical analysis
 Meaningful distribution of borrowers and exposures across
pools (no concentration in a few pools)
IRB Capital Formula for Corporate
Correlation (R) = 0.12*(1-EXP(-50*PD))/(1-EXP(-50))+

0.24*[1- (1-EXP(-50*PD))/(1-EXP(-50))]
-0.04(1-(S-5)/45) for SME adjustment
Maturity Adjustment (b) = (0.11852-0.05478*ln(PD))^2
Capital Requirement (K) = [LGD*N(1-R)^-0.5*G(PD)+(R/(1-R))

^0.5*G(0.999)-PD*LGD]+(1-1.5*b)^-1*(1+(M-2.5)*b)
RWA = K*12.5*EAD
Capital Charge = RWA*0.08

14 - - - IPS-Sendero confidential Source : Basel Capital Accord : June 2004
IRB Capital Formula for Retail
Correlation (R) = 0.03*(1-EXP(-35*PD))/(1-EXP(-35))+

0.16*[1- (1-EXP(-35*PD))/(1-EXP(-35))]
0.15 for Residential Mortgage
0.04 for Revolving Retail
Capital Requirement (K) = [LGD*N(1-R)^-0.5*G(PD)+(R/(1-R))
^0.5*G(0.999)-PD*LGD]
RWA = K*12.5*EAD
Capital Charge = RWA*0.08

Source : Basel Capital Accord : June 2004
IRB Capital Charge Example
Plug the inputs in the IRB capital formula mentioned

earlier, the capital charges are:
Input:
EAD 10,000,000 Category Risk Weight Capital Charge
PD 1% Corporate/Bank/Sovereign - FIRB 97.44% 779,579
LGD(FIRB) 45% - AIRB 42.78% 342,224

Corporate/SME - FIRB 93.00% 743,992
LGD(AIRB) 15%
- AIRB 40.83% 326,627
M 5yr
Residential Mortgage 20.67% 165,397
Rating Ba1 Revolving Credit 10.16% 81,244
RW(STD) 100% Other Retail 17.63% 141,074
IPS-Sendero KRM Overview
IPS-Sendero KRM Processes
 Yield curve smoothing

 Valuation
 Value@Risk
 Net interest income simulation
 Prepayments
 Transfer pricing
 Non-maturity deposit modelling
 Credit risk
 Credit adjusted valuation
 Credit adjusted Value@Risk
The IPS-Sendero KRM Framework
IPS-Sendero KRM Risk

Manager
Market
ALM Credit Risk Others
Risk
Default Yield Curve

NII Valuation
Probability Smoothing
Credit Adjusted TSM Parameter

E@R V@R
Market Valuation Fitting
Sensitivity &
Sensitivity & Credit
Stress Testing
Stress Testing Exposure
The Risk Management Vision
Completely integrated risk solution based on common
assumptions and methodologies
Market Asset/ Credit
Risk Liability Risk
Management Management Management
Consistent risk Reduced risk
management management
decisions costs
Common Organizational
Operational
Assumptions & Performance
Risk
Methodologies Management
Management
Regulatory
compliance Improved
Financial Economic
Capital returns
Accounting
Management Risk-Based Management
Regulation
IPS-Sendero KRM Functional Description
Function Description
Yield curve smoothing Estimates yield and other forward rate curves
Market Valuation No-arbitrage valuation of portfolio positions
Value@Risk Measures financial risk of positions and portfolios
Net Income Simulation Simulates cash flows and measures E@R

Credit Analytics Credit default analysis and credit-adjusted valuation
and risk measurement
Transfer Pricing Risk-adjusted transfer pricing
Key Advantages
 A single data sourcing and mapping exercise for all

financial risk
 Integrated market and credit risk
 No “black boxes”
 Leading thinking of Kamakura’s dedicated research
function
Assignment Of Risk Factors
 Flexible, user defined

 Interest rates
 FX rates
 Equities
 Volatility
 Yield spreads
 Term structure parameters
 Spreads by ratings
 Default rates
 Default probabilities
 Loss given default
 Recovery rates
Historical Risk Factors
 Risk factors can be user provided or computed

 IPS-Sendero KRM capable of accepting historical market
data
 Perform calculations of volatilities and correlations
 Can accept variance-covariance calculations from any
source
 Can calculate volatilities and correlations for any pair of
risk factors
Credit Risk Modelling
Macro Factors And Risk
 DUGAS
 British Airways
 The Marriott Group
 Abu Dhabi Islamic Bank Bank
 Halliburton
 Key objectives
 Identifying the drivers of credit risk
 Understanding the interactions of these drivers with
market risk drivers
 Key benefits
 Forecast how the probability of default of each
counterparty may migrate over time
 Forecast how each counterparty’s probability of default is
correlated with that of other counterparties
 Hedge credit risk against movements in macro risk drives
 Explicitly capture impact of correlations between credit
risk and market risk
Other Benefits
 Models provide significant flexibility in the selection of

risk drivers that impact default
 Maintain consistency with market pricing
 Variety in credit risk models
 Merton model
 Jarrow reduced form models
 Chava-Jarrow model
Kamakura Default Probabilities
Default probabilities from five leading models

 Structural Model
 KDP-ms: Merton Structural Model
 Reduced Form Models

 KDP-jc: Jarrow-Chava Model Based on Equity Prices and
Accounting Data
 KDP-jd: Jarrow Model Based on Debt Prices
 KDP-j+: Jarrow Model Based on Credit Derivatives
 Hybrid Reduced Form and Structural Model

 KPD-jm: Jarrow-Chava Model with Merton Default
Probability as an Additional Explanatory Variable
Reduced Form Models
Evolution of Credit Risk Management Technology
1980s 1990s 2000s
Credit Merton Jarrow Jarrow Reduced

Derivatives
Major Model Turnbull Form
Credits Jarrow Reduced
Merton Model Of Risky Form & Chava-
Loans
Debt
Jarrow
Business Altman Style Z- Credit Chava-Jarrow

Credits Score Analysis Scoring with Market Data
Retail Credit Scoring Using Loan Chava-Jarrow

Credits Application and Credit Bureau with Market Data
Data
Reduced Form Models
Introduction to the Jarrow Model
 The Jarrow [2001] model is an extension of Jarrow-Turnbull [1995]

to include random interest rates, liquidity factors and macro risk
factors as determinants of a random bankruptcy probability
 The model can be fit to
 Equity prices and accounting data
 Debt prices
 Credit default swap data
 Accounting data alone
 Retail client data
 It is a completely general credit and insurance model suitable to
all types of counterparties
 Robert Jarrow, “Default Parameter Estimation Using Market
Prices,” September 2001, Financial Analysts Journal, available on
www.kamakuraco.com
Testing Credit Models
Testing Using Historical Defaults
Which of these ratings is better?
Rating
Agency Model 1 Model 2
Bankruptcy Internal Rating Numerical Default Default
Number Company Index Rating Agency Ranking Probability Probability
1 a 0 9 A- 9 0.180 0.162
2 b 0 8 A- 9 0.230 0.207
3 c 0 8 BBB 8 0.350 0.315
4 d 0 8 BBB 8 0.360 0.324
5 e 0 7 BBB 8 0.340 0.306
6 f 0 7 BB 7 0.550 0.495
7 g 1 7B 6 0.980 0.882
8 h 0 7 BB 7 1.060 0.954
9 I 0 7 BB 7 0.700 0.630
10 j 0 6 BB 7 0.760 0.684
11 k 0 6 BB 7 0.800 0.720
12 l 1 6B 6 1.560 1.923
13 m 0 6B 6 2.030 1.827
14 n 1 6B 6 3.450 4.290
15 o 0 5B 6 3.200 2.880
16 p 0 5 CCC 5 4.030 3.627
17 q 0 5 CCC 5 2.790 2.511
18 r 1 5 CCC 5 3.650 5.782
19 s 1 5 CCC 5 5.120 4.608
20 t 1 5 CCC 5 6.780 6.102
Defaults 6
Testing from Historical Defaults is Not a
New Discipline
 Well established statistical technology from the medical
field regarding the exposure to and subsequent
incidence of disease
 Key techniques
 Chi-squared statistical tests
 ROC (receiver operating characteristics) curve and
Mann-Whitney U statistic/ROC accuracy ratio
 Logistic regression log likelihood ratios and Wald ratios
on statistical significance of parameters
Mann-Whitney U Test and
ROC Curve Accuracy Ratio Analysis
 These are tests of the “signal to noise” ratio
 Steps in the analysis
 Form all pairs of companies in two classes:
 Defaulted companies
 Non-defaulted companies
 Compare the ratings and default probabilities for each pair
 Give one point for a correct ranking
 Give half point for a tie
 Measure number of points as percent of total
 Perfect rating system scores 100 percent. A random rating
system scores 50 percent.
For the internal ratings approach, 74.4%
of the pairs were correctly ranked.
ROC/Mann-Whitney U Test for Internal Ratings Approach

Companies that Did Not Go Bankrupt
Company a b c d e f h I j k m o p q
Bankrupt Companies Internal Rating 9 8 8 8 7 7 7 7 6 6 6 5 5 5
Company Internal Rating Count of Pairs for Which Rating Was More Risky for Company Which Went Bankrupt
g 7 1.0 1.0 1.0 1.0 0.5 0.5 0.5 0.5 0.0 0.0 0.0 0.0 0.0 0.0
l 6 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 0.5 0.5 0.5 0.0 0.0 0.0
n 6 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 0.5 0.5 0.5 0.0 0.0 0.0
r 5 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 0.5 0.5 0.5
s 5 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 0.5 0.5 0.5
t 5 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 0.5 0.5 0.5
Subtotal 6.0 6.0 6.0 6.0 5.5 5.5 5.5 5.5 4.0 4.0 4.0 1.5 1.5 1.5
Total Count 62.50
ROC Percentage 0.7440
Number of Pairs 84.00
The Mann-Whitney U Test is An
Intuitively Appealing and Simple Test
Tecnnique ROC Percentage

Model 2 0.9048
Model 1 0.8690
Rating Agency 0.8571
Internal Ratings 0.7440
Model 2 is the winner because it correctly

ranks the order of risk in 90.48% of the
pairs.
The Receiver Operating Characteristic Curve Shows How
Prediction of Bankruptcy Changes at Different Default
Probability “Cutoff” Levels
Hypothetical
Receiver Operating Characteristics (ROC) Curve
Note: ROC Accuracy Ratio = Blue Area
0.9
0.8
Sensitivity: Percentage of Defaults Properly
Classified as Defaults by the Model
0.7
ROC Curve Using
0.6 Random Chance
0.5
0.4
Prediction of
0.3 Default When
Estimated Default Prediction of
0.2 Probability is Default When
100% Estimated Default
0.1 Probability is 0%
or Higher
0
0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 0.55 0.6 0.65 0.7 0.75 0.8 0.85 0.9 0.95 1
1 - Specificity: Percentage of Non-defaulting Companies Incorrectly Classified as Defaulting by the Model
The ROC Curve for the Chava-Jarrow Model is Extremely
Good, Higher than Any Other Published Model
Sensitivity:
Percentage of
Defaults Properly
Classified. (1-
Specificity):
Percentage of
Non-Defaulting
Companies
Incorrectly
Classified as
Defaulting
Chava Jarrow Results, 1963-1998
 ROC Accuracy Ratios

 92.74, Chava Jarrow Basic Model
 100.00, Perfect Model
 Size of Data Set

 1,402,919 Observations
 979 Defaults
 ROC Accuracy Ratio based on a total of 1,373,457,701
pairs of observations
 All listed companies in the US for which data was
available
Results Published by Others
Results* published by others demonstrates the relative strength of the

Jarrow-Chava Model
 Moody’s Model Data Set

 54,000 annual observations
Perfect Score = 100
 530 Defaults
Jarrow-Chava = 92.74
Falkenstein & Boral
Merton & NI/Assets = 89.95
Sobehart, Keenan, & Stein
Moody’s Model = 88.00
Falkenstein & Boral
Best Merton = 87.40

Sobehart, Keenan & Stein
Merton Model Variant = 83.50
*Adjusted from originally reported 79.9, 76, 74.8, and 67 for more exact comparison
Key Steps
 Select a particular set of explanatory variables

 Collect counterparty observations from internal or
external data sources
 Calibrate default hazard models by applying appropriate
statistical procedures
 Generate default probabilities from the calibrated default
hazard models
 Convert the resulting scores to a credit score for the
counterparty
Explanatory Variables
 Net income to total assets ratio

 Total liabilities to total assets ratio
 Relative size, ratio of total firm equity market value
divided by total NYSE and AMEX equity value
 Excess return, the monthly return on the firm minus the
monthly value-weighted CRSP NYSE/Amex index return
 Stock’s volatility of previous month’s daily prices
The Competition
 No calibration to local sources

 Proprietary, confidential models
 Not IRB compliant
 Not conducive to stress testing
 Pillars 2 and 3 ignored
The Importance Of Calibration
Credit Risk Models in KRM
Default Probability Modelling
Using Default Swaps
Using Risky Bond Prices
Using User Defined Variables
The Merton Model
Regulatory Capital
Calculation / Reporting
Comprehensive Product Coverage
Keeps transactional level details
Each product can be aligned with
different approaches
Standardised approach risk weights
Counterparty Information
Industry Definition
Align Counterparty with Industry
Rating Definitions
Recovery Rate Setup
Loss Provision
Hedge Definition
Regulatory Capital Calculation
Formulae used in KRM
Sample Basel II Report
Sample Report:
Capital Charge by Counterparty
Sample Report:
Capital Charge Comparison-1
Sample Report:
Capital Charge Comparison-2
&A

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IPS-Sendero KRM

 Overview of Credit Risk

Fear :No matter how good your institution is in risk

Links : The amount a counterparty owes you and their

Macro Risk Drivers

Probability of Exposure at Loss Given

Calculation of capital under the Standardised Approach:

Calculation of capital under FIRB:

Calculation of capital under AIRB:

Claims on AAA to BBB+

Sovereigns / Central Gov. 0% 20 % 50 % 100 % 150 % 100 %

Option 1 1 20 % 50 % 100 % 100 % 150 % 100 %

Other Assets 100 %

Higher Risk Assets 150 % National Supervisor’s Discretion

ABS 20 % 50 % 100 % 350 % Deduction

 Though easier to implement, it often leads to much

 It does not create much value other than pure

 Sovereign FIRB AIRB

 Revolving Credits AIRB

 Other Retail AIRB

 Equity Market Based Approach PD/LGD Approach

 Purchased Receivables FIRB AIRB

 Risk Parameters are estimated at pool level (PD/LGD or EL)

Correlation (R) = 0.12*(1-EXP(-50*PD))/(1-EXP(-50))+

Capital Requirement (K) = [LGD*N(1-R)^-0.5*G(PD)+(R/(1-R))

Capital Charge = RWA*0.08

Correlation (R) = 0.03*(1-EXP(-35*PD))/(1-EXP(-35))+

Capital Charge = RWA*0.08

Plug the inputs in the IRB capital formula mentioned

LGD(FIRB) 45% - AIRB 42.78% 342,224

 Yield curve smoothing

IPS-Sendero KRM Risk

Default Yield Curve

Credit Adjusted TSM Parameter

Net Income Simulation Simulates cash flows and measures E@R

 A single data sourcing and mapping exercise for all

 Flexible, user defined

 Risk factors can be user provided or computed

 Models provide significant flexibility in the selection of

Default probabilities from five leading models

 Reduced Form Models

 Hybrid Reduced Form and Structural Model

Evolution of Credit Risk Management Technology

1980s 1990s 2000s

Credit Merton Jarrow Jarrow Reduced

Business Altman Style Z- Credit Chava-Jarrow

Retail Credit Scoring Using Loan Chava-Jarrow

 The Jarrow [2001] model is an extension of Jarrow-Turnbull [1995]

ROC/Mann-Whitney U Test for Internal Ratings Approach

Tecnnique ROC Percentage

Model 2 is the winner because it correctly

 ROC Accuracy Ratios

 Size of Data Set

Results* published by others demonstrates the relative strength of the

 Moody’s Model Data Set

Best Merton = 87.40

Merton Model Variant = 83.50

 Select a particular set of explanatory variables

 Net income to total assets ratio

 No calibration to local sources

Das könnte Ihnen auch gefallen

Correlation (R) = 0.12(1-EXP(-50PD))/(1-EXP(-50))+

Capital Requirement (K) = [LGDN(1-R)^-0.5G(PD)+(R/(1-R))

Correlation (R) = 0.03(1-EXP(-35PD))/(1-EXP(-35))+